Farewell to Anonymity: How Coinbase's Cooperation with the US Government Threatens the Crypto Community

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This summer it became known that the largest American exchange Coinbase has a division of Coinbase Analytics, which develops solutions...

This summer it became known that the largest American exchange Coinbase has a division of Coinbase Analytics, which develops solutions for tracking user transactions and their identification. US government departments became interested in the company's products: the Secret Service, the Internal Revenue Service and the Drug Enforcement Administration.
The first two have already signed contracts with Coinbase Analytics for several hundred thousand dollars. The crypto community accuses the exchange of violating user privacy and cooperation with the authorities, the Coinbase management says that it only transfers public information to the departments, and the sale of analytical solutions is just a way to make money. What solutions will Coinbase Analytics deliver to the Secret and Internal Revenue Service and how will this affect ordinary cryptocurrency holders.

What Coinbase Analytics does

In early June, The Block  noticed the  publication of two documents showing that the Internal Revenue Service (IRS) and the US Drug Enforcement Administration (DEA) intend to buy multiple licenses from Coinbase Analytics. The IRS and DEA procurement documents were  released  in April and May, respectively. Neither the DEA nor the IRS disclosed the final value of potential deals, which were still pending completion. And the document on cooperation between DEA and Coinbase is no longer available.
The IRS contract says the agency's cybercrime criminal investigation department " needs a software tool that can help track different types of cryptocurrencies, not just bitcoin ." Coinbase Analytics' solution allows you to " analyze and track the cryptocurrency flows of multiple blockchains used by criminals ." Among other benefits, Coinbase Analytics also provides " some advanced privacy capabilities for law enforcement not currently found in other tools on the market ."
Under an as-yet-pending contract with the DEA, Coinbase's solutions will provide “ identity verification ” for crypto addresses both domestically and internationally. The agency notes that Coinbase Analytics "is known for the accuracy of its attribution, which can help avoid mistakes in identifying the target ." The contract also states that without Coinbase Analytics solutions, the DEA will not be able to monitor cryptocurrency movements and that " this is the least expensive tool on the market that has the most functionality for its money ." According to the details of the contract, Coinbase could have made between $ 10,000 and $ 250,000 on the deal.
The news about the cooperation of the crypto exchange with government structures caused a wave of criticism in the crypto community and accusations of selling user data. In response to The Block, a Coinbase spokesperson stated that its analytics software does not use any internal customer data, all information is obtained only from publicly available online sources and does not contain any personal data. The exchange also clarified that Coinbase Analytics is an essential tool for fulfilling regulatory obligations and protecting customer funds. Coinbase Analytics also provides its solutions to " financial institutions and law enforcement agencies to support compliance and investigate the use of cryptocurrencies in illegal activities."
It is noteworthy that before The Block article, the general public did not know about the existence of Coinbase Analytics. As it turned out, the unit was launched after the   company acquired blockchain-based analytical startup Neutrino in February 2019 for $ 13.5 million.The purchase sparked  controversy in the crypto community : the founders of Neutrino were associated with the Italian company Hacking Team, which provided technologies for spying for authoritarian regimes in the Middle East. However, according  to  Coinbase, the company has parted ways with former Hacking Team employees.

US Secret Service contract for $ 183,000

In early June, it became  known that the US Secret Service  contracted  with Coinbase to use its programs to track crypto transactions. The agreement was signed on May 8 and is valid until May 9, 2024, and its cost is $ 183,750. The contract will allow the agency to get access to Coinbase Analytics software. There are no other details in the text of the agreement.
“This is not surprising, our mistrust of you is growing, we will make your analytics software irrelevant,” Casa Jameson Lopp, co-founder and CTO of Casa, founder of Bitcoinsig.com and creator of Statoshi.info tweeted.


The Secret Service is part of the United States Department of Homeland Security. In addition to protecting the country's top officials, she is also involved in the investigation of financial crimes. In March, the Secret Service  began creating a  single cyber-fraud task force. In the future, she plans to deploy this network to 160 offices around the world.
“Coinbase collects private information about its customers in accordance with AML rules, monitors customer transactions before and after leaving Coinbase, and then sells this information along with public data to law enforcement, all without ethical remorse. Okay, this is “just business,” "Twitter user DJ Booth expressed his opinion.

Contract with the IRS for $ 237,000

On July 15, the US Internal Revenue Service finally  signed a contract  with Coinbase Analytics. The contract will enter into force on July 23 and will be valid for one year with the possibility of extension for another year. Under its terms, the institution must pay $ 124,950 for one year or $ 237,405 for two years to use the Coinbase blockchain analytics software.
Recently, the IRS has stepped up its activities in the cryptocurrency space. In August 2019, the agency  sent  three versions of warning letters to thousands of traders who misreported their tax obligations after trading on crypto exchanges. In October last year, it  released its  first guide to taxing cryptocurrency income. In the same month, the IRS added digital currency ownership to its main declaration form.
In May, the agency  was looking for  third-party contractors to help it assess whether some American taxpayers had paid taxes on crypto-asset trading income correctly. Companies selected by the IRS will have to sign a nondisclosure agreement and approve tax compliance audits.
Then the IRS described in detail what specific requirements it imposes on the decision of a potential contractor. It must provide all available information about taxpayers, report transactions, profit and loss of each of them and find " any inconsistencies in the data reported by the taxpayer. "
It is not easy to identify the taxable base for cryptocurrency trading. Therefore, the IRS also recognizes that it is difficult to calculate the taxable base of an individual who trades in cryptocurrency. A taxpayer can have “ hundreds of thousands of digital asset transactions ” per year, which can take place on various exchanges and wallets. All " these transactions should be aggregated and the respective assets valued as part of the P&L process ."
While the document details examples of how much data contractors will have to consider, it does not elaborate on which exchanges or types of taxpayers the IRS is interested in. Contractors who will take on this project may also be required to “ testify in court as a brief witness explaining the calculations derived from the baseline data ”. Probably, the department found such a contractor in the person of Coinbase Analytics.

Selling analytical solutions Coinbase Analytics as a way to recoup the costs of its creation

Back in the first wave of criticism, Coinbase CEO Brian Armstrong responded with a  series of tweets explaining that regulated crypto exchanges  must have some kind of analytical software to comply with regulatory rules.
Some users of the exchange have expressed concerns about how their data is being used, to which Armstrong replied:
Whether Coinbase sells blockchain analytics software or not, transactions on public blockchains are still tracked by any number of people ."
And for users who want complete privacy, it is better to switch to anonymous coins, says Armstrong.
Also, the head of Coinbase is confident that the use of blockchain analytical software that monitors user transactions is nothing new. These services are used by many regulated exchanges that have to comply with AML regulations. They use publicly available information, most often only to find intruders.

“Exchanges that maintain links with the existing financial system (ie the ability to connect their bank account, the ability to convert fiat to crypto) must follow AML requirements, and this often includes using blockchain analytics software to monitor transactions.” Armstrong wrote on his Twitter. “There are many things that could be better in the existing AML regulations. We did not create them, but these are the rules for the legal functioning of a fiat-to-cryptocurrency exchanger, ”  he added .
Armstrong said that initially Coinbase used external blockchain analytics providers to comply with AML regulations, but decided to acquire a specialized company because the organization " doesn't like sharing data with third parties when it can avoid it."

“Michael Gronager [founder of the analytical company Chainalysis] left Kraken to start Chainalysis. We decided not to develop this business internally and not to invest in analytical firms because I never wanted to have a conflict of interest with our clients. I didn't want to profit from the sale of your financial privacy, ”wrote Kraken CEO Jesse Powell.
Armstrong noted that building an analytical platform is expensive, so by selling Coinbase Analytics solutions, the company " wants to recoup the costs " and " build relationships with law enforcement, which is important for the development of the crypto industry ." He also said that government agencies are not the only clients of Coinbase Analytics. There is a market for blockchain analytics, and the firm sells its solutions to several clients, " not only for profit, but for the benefit of users ."

“Is there a demand [for analytical solutions] from the government? Obviously. We have our own internal tools that we use, but developing these tools and selling them, stimulating competition and accelerating development in an anti-private space is contrary to our values. How can you resist the use of customer data to gain competitive advantage? ”Continued to reflect on the conflict of interest Jesse Powell.

Coinbase User Sues IRS

It is noteworthy that cooperation with government agencies may not always be lawful and even necessary. So, on July 16, blockchain lawyer  Jim Harper  sued the IRS and its tax agents,  accusing  them of violating his privacy and due process rights under the Fourth and Fifth Amendments to the US Constitution. Harper believes that the IRS obtained illegal access to his financial information.
Last August, he became one of the recipients of the aforementioned IRS letters. The agency wrote that they had reason to believe that Harper did not pay taxes on the sale of cryptocurrencies. And the plaintiff himself claims that he has fully paid all taxes from trading digital assets since 2013. The IRS has never said where it got the data from, but Harper believes it may have come from an   IRS request for 13,000 account data transferred to Coinbase in early 2018. Harper himself is a client of three exchanges: Coinbase, Abra and Support. They all promised to keep his data confidential.
Harper's lawyers argue that the financial data was obtained by the IRS without the necessary subpoena or court order. In doing so, the IRS violated the Fourth Amendment by unofficially requiring Mr. Harper to provide financial statements from a third party, although he had no specific suspicion that he was breaking any law.
The Harper case is an opportunity to achieve some restrictions on the actions of government agencies. In theory, this could result in a class action lawsuit that any recipient of the ill-fated letters from the IRS last year could join. The case has prospects for a decision in Harper's favor. After all, earlier, the Taxpayer Protection Service (an independent department of the IRS and its official regulator) noticed that one of the letters sent out did indeed violate the 2014 Taxpayers' Bill of Rights, applied by Congress. Harper’s victory would set a precedent and allow for a clearer picture of the relationship between regulators and crypto companies.

Finally

There are specialized companies in the crypto industry that are engaged in tracking transactions. The most famous examples are Chainalysis and Elliptic. While they use their tools to monitor the movement of funds on the darknet, the crypto community has concerns that their technology could be used to rob the privacy of ordinary users. Coinbase Analytics contracts with US government agencies are a prime example of these fears having a real basis.
However, clients of regulated exchanges must be prepared for their data to be released to law enforcement - this is the flip side of security provided by controls.

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